When the 2008-09 financial crisis hit, my husband and I were debt-free and building our savings. We were proud of what we'd accomplished, and I used to stare at our savings balance with a smile after every payday.
At the time, all I seemed to hear was that we Americans had to spend our way out of a recession, that spending was the key to growth. Besides $862 billion in emergency government spending, everyday joes and janes were encouraged to spend through home-buyer credits and programs like Cash for Clunkers. (This wasn't unique to the current administration, either; the former administration encouraged Americans to “go shopping,” as well.)
Some people say these programs were a success — that Americans are eager for their government to tell them what to do. Others believe that spending is what led to financial disaster in the first place, and more spending isn't the answer.
You know what? I honestly don't care. I'm more focused on my personal economy. My husband and I made great headway with our personal finances, and we aren't about to stop and jeopardize our future by buying a new car or a flat-screen TV. We have goals, and we're set on hitting them. Someone else is going to have to buy those cars and houses, because we're focused on building our financial future.
But a recent article in Fortune, “The Naked Stimulus: Why Savings Stimulate More than Spending,” piqued my interest, and I came away with a different understanding of why some people argue that spending our way out of a recession doesn't work.
Writer Shawn Tully explains that using basic economic math, you can't borrow from the savers (the taxpayers) to give to the spenders (the government) and expect that to change the GDP. Tully writes:
All savings are spent…GDP measures all spending on all the goods and services that America produces. Savings translate, dollar for dollar, into a major component of that total spending: investment. All the money that the administration successfully moves from savings to consumption simply channels one type of spending to another, in precisely offsetting amounts. It's like filling a swimming pool from one end, and draining it from the other end. The level doesn't change. Nor does GDP change when the government drains investment to lift consumption.
How do savings translate into investments? When we save money, most of us don't hide it in a jar on the top kitchen shelf. Sometimes we buy stocks, which provides companies with money to expand. Sometimes we deposit our money into savings accounts or buy CDs, which the bank lends to corporations or to the government through the purchase of Treasuries. Basically, the money is spent whether you buy a flat-screen TV or deposit it into a high-interest savings account. Even when banks tighten up on lending, they still invest in Treasury bills to earn interest.
The exception to the rule
Tully concedes that there's one situation where borrowing could raise the GDP, a situation that he says influenced the theories of British economist John Maynard Keynes. During the Great Depression, when Keynes formulated his theories, people didn't trust banks, so they kept cash in safes or under the mattress. This meant the money sat outside the system, so the federal government encouraged the hoarders to buy Treasuries.
But that's hardly the situation we're in today, where most people keep all of their money in the banking system, and most deposits are insured.
Tully hypothesizes that had the government not intervened by borrowing money, the redirected money would have gone elsewhere:
Two other components of GDP would have to be larger to offset the almost $900 billion in spending and borrowing. First, private investment would be higher, because of the bigger pool of savings, a great sign for the future…Second, the U.S. wouldn't have to borrow nearly as much from abroad. As a result, the dollar would be lower versus other currencies, reflecting its true value.
Hence, imports would be more expensive, and our exports far more competitive on the world markets. The rise in exports would help offset the hit to GDP caused by lower consumer spending. Bigger investment and exports on a tear? That's certainly a good alternative to the results of the stimulus.
Tully believes it's possible that our current situation would be the same, but the outlook would be better for our economic future. What do you think of the theory of spending out of a recession versus saving to stimulate the economy?
J.D.'s note: Though we generally try to steer clear of politics at GRS, that may be tough today. This topic is inherently political. All I ask is that during this discussion, you be respectful of each other. Debate is great, but please leave aside the name-calling and gross generalizations.
Author: April Dykman
As a freelance writer, editor, and blogger, April Dykman specialized in personal finance, real estate, and entrepreneurship topics. Her work has been featured on MSNBC, Fox Business, Forbes, MoneyBuilder, Yahoo! Finance, Lifehacker, and The Consumerist. Now she does direct response copywriting but, in her free time, April is a wannabe chef, a diehard Italophile, and a recovering yogi.